Over-withholding isn't always unwise

• A big refund may mean that you lost out on interest income, but it also could have positive repercussions.

CHICAGO — Getting a big tax refund is supposed to make you feel guilty.

Financial planners say it means you've had too much withheld from your paychecks. You let the government keep your money and failed to collect interest for all those months. You also deprived yourself of the opportunity to earn an even greater return.

In a perfect world, your withholding would be exact and you and Uncle Sam just could call it even. And you would put all the extra dollars in every paycheck to work instead of waiting for a fat check the following year.

But if you count on a refund, don't feel bad. It doesn't necessarily make you a lousy money manager, especially in these challenging, low-interest-rate times.

And you have lots of company.

Even with increasingly sophisticated tax software that makes it easier to calculate proper withholding, most people choose to come out way ahead at tax time. About 75 percent of individual taxpayers get a refund every year and the average amount is about $3,000.

Through March 10, the Internal Revenue Service already had issued more than 59 million refunds worth $174 billion for the 2011 tax year, for an average of $2,946.

Mark Steber, chief tax officer for Jackson Hewitt Tax Services, prepares returns for family members and finds they all love a big refund. He doesn't discourage them even though he could argue against over-withholding.

"You can say you need to be better organized, just like you need to get more exercise," Steber says. "But people need to find what works for them."

Besides, he says: "My wife thinks I'm smarter if I get us a large refund."

Here are some reasons why having more withheld than your expected tax bill can make sense:

It AVOIDS DEBT TRAPs

Owing taxes can lead to long-term trouble. Taxpayers who are out of work or have other problems often end up with a bill they can't pay right away. Accrued interest and penalties can increase the amount owed significantly.

Tax attorney Lu-Ann Dominguez in Fort Lauderdale, Fla., sees painful cases all the time in which debt issues snowballed because of insufficient withholding. Many of her clients weren't able to write the IRS a check, so they didn't file.

That leads to the world of IRS collections, which can involve tax liens, levies on wages and bank accounts, ruined credit and problems that last for years. In her work for the Gunster law firm, Dominguez has seen 50 tax liens for more than $100,000 in the past month, most involving individual taxpayers.

It PROVIDES A WINDFALL

Receiving a cash infusion every spring can provide a much-needed lift. After a year of focusing on living expenses, many taxpayers enjoy having some flexibility.

A big check doesn't have to be wasted. It's common to sink the money into home improvements, college savings or retirement accounts.

Like most other certified financial planners, John Rohrbeck isn't a fan of large refunds. He can accept it for some clients, however, as long as it is banked or otherwise set aside wisely.

"If they save it, invest it, use it to pay off debt, build their emergency fund, great," says Rohrbeck, president of Tax & Financial Strategies Inc. in Birmingham, Mich. "But if they spend it on another trip to Disney World or another big-screen TV — bad idea."

it prevents TAX SURPRISES

Over-withholding can serve as a buffer against the unknown.

Actions you may not have anticipated when you set your withholding level can result in sizable tax hits. Taking money out of an individual retirement account or 401(k) or selling stock could push your tax return into the red. So could bonuses, corporate dividends or hefty moving expenses.

Many taxpayers also continue high withholding due to uncertainty about possible changes to the tax code.

It can be difficult to predict what you might owe if you have a complicated tax return. If your taxable income varies widely, withholding enough to be on the safe side makes sense.

No one wants to be on the hook for thousands of dollars in April.

It FORCES SAVINGS

Using a big refund as forced savings is a lazy but easy way to set money aside.

Personal finance blogger J.D. Roth, editor of the Web site GetRichSlowly.org, confesses to liking lump-sum windfalls as a way to save. He used the approach for years as what he calls a psychological trick to remove the temptation to spend immediately, putting the annual checks toward savings, debt payments and indulgences he wouldn't otherwise have been able to pay for.

Roth has since sworn off getting large refunds and the "mathematical penalties" they entail after developing more willpower. But if the practice helps someone else avoid squandering their money, he's all for it.

"I would rather have people save money in a suboptimal way than to have them not save money at all," he says.

It COSTS LITTLE IN LOST OPPORTUNITIES

The meager interest rates offered by CDs and money-market savings accounts mean you're not missing out on much income by waiting to get your money.

That will change as rates rise, but they have a long way to go. One-year bank certificates of deposit pay an average of 0.34 percent and money markets average a scant 0.14 percent, according to Bankrate.com.

The Tax Institute at H&R Block ran the numbers for different scenarios and found that the opportunity cost for overpaying taxes isn't much at current interest rate levels.

Take the case of taxpayers who set aside $100 per pay period, or $2,400 over the course of a year. If they had put the full amount in an interest-bearing checking account with typical returns of 0.25 percent for a year instead, they would earn interest income of just $6.

That's a little over $5 after taxes — not much of a disincentive against fat annual refund checks.

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